So Why Didn't They Borrow Trillions To Rebuild The Economy?

Because no one was lending to the British Government

An interesting little question from Danny Blanchflower - who as an economist should actually know the answer - mentioned here. Worth having another little look at the correct answer.

Here is a question why didn't the tories borrow a trillion pounds - or even two - between 2010 and 2020 at really low interest rates and invest/repair them in schools, infrastructure and hospitals, train doctors and build lots of houses roads, railways, clean up the water supply, and rebuild what was needed

I am just an old economist who wants to understand why they did austerity instead and now are borrowing really expensively> Just asking for a friend (me..)? Why didn't they?

The correct answer is because no one was lending to the British Government. And raising interest rates high enough to get them to do so would have been a reversal of the entire economic programme being followed at the time.

Now it is a logical question, a fair one. Gilts coupons, so the price government paid for borrowing, were in real terms around and about zero for a decade and more. Gilts could be issued with a 1%, 2% coupon, inflation was running at 1 and 2%. Short term borrowings often carried a negative cost, longer term money was indeed sometimes available at zero real cost.

So, why shouldn’t government go and borrow a trillion or two and really invest in Britain? Sort out a number of infrastructure problems and all that? Or, as many say, government should have done that.

One answer is that even if money’s free in carry cost if you’re then going to piss it up against the wall that’s not going to work. We can look at the costs and benefits of HS2 and just thank our lucky stars they didn’t raise more to spend on such vital and useful pissantery. But that’s to be realistic like we are. There are still deluded fools out there who think that government can spend money usefully.

The answer to those deludes is that the interest rate upon government borrowing was not, in fact, low. To a reasonable estimation in fact no one at all was lending to the British Government.

So, back when all this quantitative easing started the national debt was around 50% of GDP. It’s now around 100% (we really don’t need greater accuracy than that). UK GDP has gone from £1.9 trillion to £2.3 trillion over the same period. Or, the national debt has gone from (1.9 x 50% to 2.3 x 100%) £950 billion to £2.3 trillion. Or, it has grown by £1.3 trillion. You know, -ish, -ish.

OK, so how much did the Bank of England buy? £900 billion.

Or, again, we can say that the vast majority of “borrowing” by the government over this period of time was not, in fact, borrowing. It was money printing.

One aside, there was of course much more gilts issuance over this period because old gilts matured. And of course, don’t be silly, government never does actually pay off debt. So, new gilts had to be issued to pay off old ones. By concentrating upon totals outstanding we’re ignoring all of that and that’s fine.

So, £1.3 trillion *more* borrowed over this time period. Of which £400 billion was put in by willing lenders at the interest rates on offer. The rest of it the BoE couldn’t find willing buyers for at those interest rates on offer. So, it printed money instead and bought the bonds that way.

Now the above is an unconventional way of looking at it. It’s also a true way - this is economics, there are many true ways.

So, one answer to why not borrow another couple of trillions is “Who the fuck from, Danny?” We’ve already found that no one wants to lend to us at the interest rate we want to pay - that’s why we’re printing. If we offer more and yet more gilts out to the market then obviously we’re going to have to pay higher interest rates. Which means that borrowing £2 trillions real cheap isn’t possible - because it wouldn't be real cheap to borrow £2 trillions.

And, well, we could have just printed another couple of £trillions, that’s true. But when we use printed money to actually go do something in the real economy - as the covid QE was so used - then we spark inflation in that same real economy. It’s only if the QE cash stays floating around in the financial system that we get only asset price, not general, inflation.

And, sorry, but it gets worse from here too. You know that £700 billion (QT has already reversed some of the QE) that’s sitting in the central bank reserves of the commercial banks? The stuff that we’ve now got to pay 5.25% interest on? Umm, higher than current gilts yields in fact? That’s the other part of QE, d’ye see?

We’ve printed money to buy those QE gilts. But we’ve not actually printed it, haha, no, we’ve made it into central bank reserves. See, the type of money made by the Bank of England is narrow, or base, money. And narrow, or base, money is simply notes and coins plus central bank reserves of the commercial banks. Just what it is. So, if we “print” more and it’s not notes and coins then it has to become those central bank reserves of the commercial banks. On which we are now paying 5.25% which is more than the gilts yield.

Now, true, we can reduce the central bank reserves, that’s what QT does. We created them by QE, reversing QE is QT, so that destroys those reserves. Coolio. But when we do that we’ve got to sell those gilts we paid for with our newly printed money. That’s how we get that money we printed back so as to reduce the narrow money supply after all. And we bought those gilts at 1 and 2% yields and now we’d have to sell them at 4 and 5% yields. That is, we lose 30 to 50% (the real number is somewhere in that range) of our capital.

Borrowing another couple of £trillions - even if, laughably, we assume govt could spend it well - would not have been cheap. Because, by and large, no one was lending to UK government at those low interest rates. So, we could borrow more and push up interest rates - not cheap. Or we could print the money and push up inflation even more - not cheap. Or we could do QE and now do QT to remove the inflation - not cheap.

The answer why we didn’t borrow a couple of trillion pounds nice and real cheap is because we couldn’t borrow a couple of trillion pounds nice and real cheap.

Danny Blanchflower is an economics professor at an Ivy League university. I’m a freelance scribbler. Danny B used to sit on the Bank of England’s Monetary Policy Committee. I did not and do not.

I’m sure there’s a clue to the state of the world in that paragraph just above.